Maidenform Brands: Strong and Growing

Maidenform Brands (MFB) design, source, and market a range of intimate apparel products in the United States and Canada. Its products include bras, panties, and shape wear. The company offers its products under the Maidenform, Flexees, Lilyette, Sweet Nothings, Rendezvous, Subtract, Bodymates, and Self Expressions brand names. Maidenform Brands sells its products through department stores; national chain stores; mass merchants, including warehouse clubs; and specialty retailers, licensing income, and off-price retailers, as well as through company-operated outlet stores and Web sites.

Investment Thesis

MFB is a compelling long investment based on an incredibly cheap valuation, strong free cash flow generation, solid business fundamentals, value adding uses of free cash flow, and terrible investor sentiment. MFB has been trashed (down ~50% since July) on concerns of continued weakness at the company’s core vendors such as Macy's (M), Target (TGT), Wal-Mart (WMT), etc. I think the selling has been way overdone, MFB trades at a huge discount to the peer group and even a discount cash flow valuation which assumes no growth in perpetuity from FY 2007 results (we are already in Q4 so these results are very certain). MFB has sold off in sympathy with other consumer discretionary stocks when in reality their product is more of a staple with a solid replacement cycle. I think MFB will appreciate to a valuation closer to the peer group with a target price north of ~$18.

• Intense selling has brought about a compelling valuation, business fundamentals sound

MFB has seen its share price nearly cut in half from July levels. In early November, the company missed Q3 earnings ($.32 vs. $.34 consensus) on a $10m revenue shortfall resulting from weaker sales at department stores and mass merchants. The slowdown in consumer spending is not a new revelation and the market has more than priced in a slow-down at these price levels. According to my steady state DCF valuation which assumes no growth beyond FY 2007 levels, which as I mentioned above we are already in Q4, the stock is worth $16.40. On a public multiple basis, the stock is worth $22. Furthermore if you apply the valuation that Warren Buffet paid for Fruit of the Loom and Russell, the stock is worth $19. Please note that my model uses the lowest estimates on the Street. This valuation looks enticing given the context that MFB expects revenues to grow 4-7% in FY 2008 and EPS to grow 10-15%. In addition, MFB is yielding a healthy 12% on a free cash flow basis.

• Business is fundamentally sound, selling a staple product with solid replacement cycle

Although the stock has been crushed, the underlying business fundamentals are solid. MFB competes in a huge market $10.3 billion in annual sales that grew ~5% last year. MFB enjoys several competitive advantages such as leading market share, strong brands, and existing relationships with large retailers (Macy’s, Target, Wal-Mart, etc.). MFB has several growth opportunities such as internet sales, expanding into international markets, and increasing outlet store locations.

I think the Street is significantly overestimating the impact that a consumer slow-down will have on MFB. The Street is looking at MFB’s product as completely discretionary purchases when in fact the product is more of a staple. Bras and underwear have stable replacement demand even in a soft economy. Furthermore, MFB’s products generate demand from body shape changes. During my routine Google search for “women’s underwear”….(that was a joke), I stumbled across the factoid that women on average change bra sizes 6 times during their lives due to weight loss/gain, pregnancy, child birth, and medication. The point being the steady state demand cycle is stable even in a slow economy and the product is more of a staple than the Street’s valuation is implying.

• FCF being used to add value

As I mentioned before, MFB throws off a lot of FCF. Management has been using this FCF efficiently to add value to the company by repurchasing shares and paying down debt. MFB bought back $7m worth of stock in Q3 and has to quarter to date bought back $3.3 million in Q4 which equates to ~635,000 shares bought during the past 2 quarter which is ~3% of shares outstanding. In addition, MFB has reduced the debt balance by almost 20% in 2007. Future debt repayments will be accretive to EPS. I expect MFB to continue to buy back shares and pay down debt and I also look for them to acquire/license a more upscale bra brand.

• Street sentiment is terrible, relatively high short interest

The icing on the cake for MFB is that the Street hates it. Of the 5 analysts covering the name, 4 have “Holds” and only 1 has a “Buy. In addition, 10.6% of the float is shorted which would take 9.1 days to cover. At this valuation the stock seems ripe for an upgrade and the slightest bit of good news could squeeze the shorts.

Risks

• US economy goes into a prolonged recession, although not a stock specific risk, a slow-down in the US economy would likely hurt retail sales. I think an economic downturn has already been priced into the stock at these levels.
• Company overpays to acquire a higher end bra line and destroys firm value. The management team is pretty well respected and seems focused on creating share holder value as evidenced by their use of FCF to date.

Disclosure: Author holds a long position in MFB